Letter of Credit Blues - the tragedy of export sales growth lost to admin hassle

Ed Marsh | Mar 3, 2014

"L/Cs are too complicated for us.  We're just a small company"

export global sales are discouraged by the expense and complication of letters of creditI'm convinced that bankers don't like dealing with letters of credit for international payments any more than you do.  After all, L/Cs are complicated, boring, and full of risk.  Small mistakes can have big (and unhappy consequences.)  Of course bankers make quite a bit of money writing L/Cs - so there's some appeal to them financially.  

In my experience there's a common distribution of L/C familiarity among business people and bankers.  The vast majority are ignorant of what an L/C is.  A minority knows enough "to be dangerous" but not to really advise with any expertise (and tosses the lexicon around for maximum effect!)  And then a precious few are really conversant and expert in the science and art of letters of credit.  

It doesn't need to be a business root canal!

Do L/Cs serve a specific market requirement?  For sure.  But they are neither the first nor last answer for general B2B business growth initiatives in export markets.

Most companies considering global sales obsess over the detail of getting paid.  I get it.  They aren't doing this for entertainment only - and getting paid is fundamental to their business objectives.  

But getting paid by international customers is hardly a problem for which only a single fix exists.  L/Cs may be a traditional solution; they may be a profitable solution for banks; and many may refer to them from force of habit.  But other options include:
  • other bank centric products such as documentary collections
  • wire payment directly against invoices (in advance, upon shipment, upon delivery, according to open account terms, or some combination)
  • PayPal
  • credit card
These can be substantially less complicated than L/Cs, and depending on the details, much less expensive.

And importantly, the guarantee element of the L/C is not without risk for the seller.  So the commonly accepted trade off of hassle and expense for risk mitigation isn't a sure thing.

For buyers an L/C will typically be deducted from their borrowing base and therefore costs them the funds well in advance of delivery.

For regular business transactions - not just eBay

Many companies dismiss PayPal as a viable vehicle for receiving substantial international B2B payments.  It's expensive (2.9-3.9% + transaction fee + 2.5% on the currency conversion as of this writing) but it's widespread (193 countries & 26 currencies.)  And it allows both parties to work with their currency of choice.  While it's convenient there are transactional limits which vary by currency but roughly equate to USD $10,000.

So for B2B transactions of up to approx $20K (assume a portion due with order and a portion at shipment) this is a viable solution.

Wire payments

Wire payment is often the easiest and least expensive solution.  Depending on the relationship between seller and buyer, and the size of the transaction, the timing can be negotiated.  Naturally everyone wants to cover their exposure.  The seller wants to have guarantee of payment and the buyer wants guarantee of receipt of satisfactory products.

Some industries (capital equipment) have standard expectations for progress payments that both ensure the commitment of the buyer and provide working capital for sellers of products with long lead-times and custom design/manufacturing.

Therefore the biggest challenge is often agreeing on the schedule for wire payments - prior to shipment or after.  Generally, recognized American companies don't experience too much push back on requirement of payment in full prior to shipment.

Taking care of customers

But remember, this isn't some sterile transaction.  This is part of your effort to grow your business profitably, globally.  If you are serious about reaching some portion of the 95% of the world's consumers that lie outside the US, you should consider your policies in the context of customer friendly practices.

And in that light, neither L/Cs (hassle and expense for you and the buyer) nor wire payment in advance is particularly 'friendly.'

Getting really crazy...or not

Here's where you may decide I'm nuts.  How about selling internationally on open account terms?  OK, not to every buyer that stumbles onto your website, but how about channel partners with whom you are building mutually beneficial business relationships?

How about selling your channel partners on open account terms?  'Nuts!' you say?  Not really.  Here's the trick.

Foreign receivables credit insurance

Seriously.  You may have heard of Ex/Im Bank's insurance policy.  It's a good offering - but not the most friendly for your finance folks to administer.  There are other great options which have low thresholds for reporting, small deductibles, low premiums and ease of policy administration.  And what they provide is awesome:
  • payment on formal default
  • payment on practical default (90 days past due)
  • coverage for non-convertibility of currency (imagine having an invoice outstanding when Greece leaves the EU and your customer can't send new drachmas and can't access euros!)
  • and protection against other mind bending scenarios
And a policy of this sort could actually be written to include your domestic receivables too (probably more risk there than you assume) and render your accounts receivable (even international) substantially available as an asset against which you can borrow.

The point is that whether your company is $2MM or $70MM Letters of Credit are an expensive hassle.  There are other solutions that will satisfy your need for payment security and your customers' desire for an agreeable business partner.

Don't discourage business because you dread L/Cs!

In whose currency

And then there's this question....more will follow in another blog post, but...this isn't the huge complication many fear.  In fact it could be an interesting way to bump your margin a bit - and for the risk averse, there are simple and inexpensive ways to lock your margin in against any potential fluctuation.

Want to dive deeper into the FX question for B2B exports in the meantime?  Download our free eBook here.


Click me


image - Jurnal Perkuliahan